Toxic Debt

Again, speaking from the wonderful position of outside observer (wonderful because it justifies my complete ignorance), a few ramshackle thoughts on the grave debt crisis facing the “United” States of America.

I think it is generally the right thing for a country (and an individual) to maintain a balanced budget. I don’t think this is always the case. When a budding doctor is in medical school, they might be running up debts, in the reasonable assumption that they will pay them off once they are qualified and well-paid. And when an economy is in recession, my (again, limited) understanding is that a budget deficit is more reasonable, given a) the lower tax revenues that result from the contraction in the economy, and b) that government spending can help to pull the economy out of recession, or at least ease the downward dip (the G in C + I + G + X – M). But generally, budgets should balance.

I also think it is fairly clear that the huge debts that the US Government faces today ($14,548,054,858,928 last time I checked). Are the result of both Democrat and Republican presidents. The deficit has increased substantially in the last couple of years under President Obama (from $10.0T in September 2008 to $14.5T today). And the deficit increased substantially under President Bush II (from $5.6T in September 2000 to $10.0T in September 2008). It increased substantially (by around 350%) under Reagan and Bush I, and slightly under Clinton. The point is, that for Republicans to lay sole blame for the crisis at Obama’s door displays an acute medium-term memory loss.

But “how we got here” is less important than “how we get out”.

In my opinion, the way to do that is gradually. I understand that economies prefer subtle, barely perceptible adjustments to the rudder, rather than sudden, sharp shocks, or violent, lurching changes of course. These subtle adjustments should have been made over the last ten years, and the sad fact that they haven’t, and that we therefore now face such an imminent “do-or-die” moment, reflects poorly on the short-sightedness of the current administration, and the last years of its predecessor. But “we are where we are”, and from here, the best solution seems to me to be to wind down the deficit smoothly and gradually, over a number of years. Restoring a deficit of over $1,000,000,000,000 overnight appears to be more politically motivated, than economically sound.

I also believe that these adjustments should be on both the revenue and the expenditure side. That is, the best solution will encompass both tax increases and government spending reductions. I think this is both good economics (because it mitigates the severity of changes to either taxation levels or government spending required to balance the budget), and good politics (because it involves compromise between Democrats and Republicans). I believe that you can be for tax cuts and against balancing the budget, or against tax cuts and for balancing the budget, but that you cannot be for both. Especially if you are determined to balance the budget in the immediate term.

But what if no compromise is possible, and no deal is reached in the next 4 days?

Given that there seems to be little historical precedent for the largest economy in the world defaulting on its debt, we can only guess as to what the implications of such a default might be. But I think it is safe to say that they will be “bad”. Stocks will undoubtedly crash, as they have been doing for the last week (the Dow Jones has declined by around 5% during this time). And US interest rates will climb, making already steepling interest repayments even more expensive. And perhaps the psychological impacts of such an unprecedentedly gargantuan economic catastrophe on consumer and investor confidence will be even more profound, and permanent.

To my untrained eyes, the tragedy here is that it is not just economic ill-discipline that has brought us to the edge of this precipice, but political recklessness. It seems as though American politicians, of both colours, are more interested in playing political hardball and petulantly digging their heels in, than saving the nation from economic catastrophe. I would say it is a “dangerous game”, but it’s now far beyond a game.